Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

Yields on residential property point to scale of the challenge

The daft.ie report has published a quarterly series on yields for residential property since 2006. The national average yield has moved between 3% and 3.5% over that period, with some areas of Dublin and Limerick enjoying the highest yields of between 4% and 4.5% in the same period.

Yields are a hugely important indicator in property markets, especially in property markets where the rental segment is significant, as it is in Ireland’s urban centres. Indeed, given the much greater integration of rental and sales segments of the market over the past decade (i.e. you can now rent accommodation of the same standard as accommodation you can buy), yields are one of the most important medium-term indicators of health. Mathematically, of course, yields are essentially just a variant of the house-rent ratio. Rebecca Wilder shows just how far Ireland is an outlier by that measure over on newsneconomics.com – but crucially her chart doesn’t take account of how interest rates have changed. If the expected long-term interest rate has changed from, say, 12.5% to 5%, a movement in price rent ratios of 2.5 might be rational.

So, if we take in to account interest rates, what does Ireland’s property market experience over the past 10 or so years look like? The graph below shows the average yield for Dublin, using daft.ie and CSO rents as well as median interest rates for borrowing, from 1996 on.

Yields for residential property in Dublin, 1996-2009
Yields for residential property in Dublin, 1996-2009

Until I can get the CSO data on rents for pre-1997 (not available online), we won’t know what happened before EMU and the euro were factored in. Nonetheless, it is the case that interest rates went from being in the 7-8% range before 1998 to 6% or less from 2000 on. The problem is that yields show that people seemed to believe that the medium-term average cost of borrowing would be in the 3% range, not in the 5% range. The potential elephant in the property market room, therefore, is that the yield realistically will have to settle at somewhere close to 5% – perhaps 5.25% or so – to have anything like a normal property market.

Oversupply on the rental market currently suggests that rents may fall steadily over the coming year. If rents were to fall 5% a quarter until mid-2010, the average Dublin would be €866, compared to a peak of €1,131 in early 2008. Rents would be at levels last seen in 1998. A yield of 5.25% would suggest an average house price in Dublin of €181,000, compared to a peak of €430,000.

Therefore, it seems that the post-Celtic Tiger property bubble, ca.2002-2007, did more than churn out too many properties. It also knocked out of kilter the rent-house price ratio. This creates two levels of correction in house prices. The first is having to deal with overproduction of houses between 2002 and 2008 – by my estimates 12 years supply were built in just 7 nationwide. The second is getting used to medium-term interest rates that won’t be 3% as the market seems to have hoped over the last few years, but perhaps 5-6%. For Dublin yields to adjust to a level of 5.25% in an environment where rents look like falling 33% from their peak, house prices would have to fall almost 60% from the peak.

I guess some might see an upside of having such low interest rates at the moment, in that the market will have a bit longer to adjust. That of couse is a downside for those hoping for a swift return to normality over the coming years.

  • Fergus O'Rourke ,

    I am of the view that interest-rates are not relevant to any great extent, if at all. I have not been able to check the longer time series (available in the U.S. and the U.K.) but my recollection is that the data from them confirm that.

    • John ,

      Hi Ronan first visit to your blog today (have known about it for a while via DAFT etc.). It’s really excellent well done.

      Intuitively you would expect some correlation between interest rates and yields. If you could get a risk free return on your money why would you take the risk of investing in a property, maintenance, break in rent etc. unless there was a premium (excepting potential for capital gain which is a different argument) ?

      Although I understand your logic, and agree with your point about the elephant in the room, can you really see a 60% drop in house prices as realistic ? I’m biased having bought in early 2007 but your example would bring prices back nearly 15 years in say a 3-4 year period.

      Would be very interested to hear your thoughts on negative equity and the social implications of it for the next 5 years. I know you’ve touched on it in your latest post about house prices when you retire. Is it fair to summarise it as “if you bought in 2006/2007 and took out significant mortgage then you’re looking at negative equity for 10+ years” ? this would tie in with UK experience of early 90s.

      If this does happen I would imagine it will have huge implications for the economy and society – 15-20% of borrowers defaulting on their mortgages (bank estimate probably < 1%), depress house market even further, mass emigration particularly of skilled people.

      John

      • Ronan Lyons ,

        Hi John,
        Thanks for the visit and the comment. I’m actually working on that very topic – the extent and depth of negative equity and the implications thereof in a high unemployment situation – at the moment. The bones of this research are scattered around the blog, so maybe search for negative equity and have a read (there’s 3/4 posts in total I think). I’m hoping to have a more formal research output to show for it all in the next couple of weeks.
        R

        • John ,

          Thanks Ronan, will have another dig for negative equity and keep an eye out for your next research.

          John

          • melissa ,

            I left Dublin Ireland in 2003 only to return to a land of urban sprawls around Dublin and the M50 in 2008. Now with the current economic situation I think those individuals who purchased houses in 2003 are going to face a sharp decrease in property value of 2010.

            Leave a comment